The subprime mortgage crisis was triggered by several factors. There is a “natural” rate of home ownership which has held up statistically for many decades, it hovers around 63%. Both political parties, for widely differing reasons, over the period of almost two decades, pushed for relaxation of qualifying standards to try and elevate the percentage of Americans who qualified, which pushed the percentage of owners up to over 68%. Lenders for both risk and liquidity management, insured and repackaged loans for sale to third parties. This gave them back most of their capital to make additional loans. The lenders weren’t pushed to hold a portion of the risk and over an extended period the standards became more and more relaxed. This was based on a widely taught statistical model that if you spread the risk across many parties, the risk was diminished to the point of being negligible. The fallacy of this thinking is that the risks in the debt crisis were proven to be more correlated than originally thought. The level of subprime loans rose from under 5%, meant to be exceptions to the processing, to over 20% of all mortgages originated and in certain high-price submarkets such as California, Arizona, Nevada and Florida the percentage was much higher. This additional 5% rise in home ownership drove many sub-markets and the material supply and construction industry nationally, which created linkage to the national economy for finance, materials, construction and services.
As the crisis unfolded, it became a negative financial feedback loop in areas which had higher percentages of this type of job creation. Construction slowed down, the construction worker lost his position, which affected his ability to repay, which hurt his mortgage holder, which caused pain with the portfolio insurer and eventually the entire financial system began to question the value of what was being held on their balance sheets. Once mortgage insurance, values, and credit began to contract the feedback loop carried backwards into larger lender which held the mortgages, but currently being felt in the smaller community banks which were giving the builders and developers funds for construction of new homes. In fact the contagion spread to destabilize smaller sovereign countries such as Iceland.
The Home-Buyer Tax Credit, low mortgage interest rates, cessation of most of the new home construction, time to heal and wide scale reduction in prices have allowed many housing units to be absorbed naturally in the market. The low-hanging fruit has been done at this stage.
The issue remaining is what about the rest of the crisis and inventory. The shortest answer is keeping the first time buyer credit intact a while longer (perhaps one more year) and more time at these low rates, as long as inflation isn’t being touched off. The crisis took many years to build and will take more years to pass. Individuals need time to reset their expectations, for the market to...